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Choosing the Right Dealer
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After a positive decision is made to participate in speculative trading in the FOREX market, a newcomer should first choose the dealer for conducting a trade. The right choice greatly influences the final success of the whole enterprise. Nowadays, the market is overcrowded with companies and banks offering their services to individual traders and investors to access the currency market. It is not easy to make the right choice without a certain set of criteria. These criteria best correspond to the interests, preferences, and means of each individual trader, and to the trade strategy and tactics chosen by him.

The best way to find the right dealer is to compose a list of questions to ask the dealer, before making a final decision in favor of the preferred company or bank. The following are suggested questions that should be answered by the dealer before you make the decision to open a trading account. Included are my recommendations about the optimization of mar­ket operation conditions:

WHAT IS THE AMOUNT (VALUE) OF THE IIVFRADAY AND OVERNIGHT MARGIN AND CORRESPONDING LEVERAGE? Many reliable dealers (especially those who offer Internet trading) restrict the margin by 2 to 5 percent, which provides money contract leverage between 20:1 and 50:1. Such terms seem quite reasonable and acceptable, considering the risk/investment efficiency ratio. Higher margin requiremerits yield lower investment efficiency, whereas a lower margin means that the dealer bargains against his own clients and will do everything possible to prevent his clients from winning. It is difficult to work under such terms because you will confront even more trading problems.

WHAT IS THE MINIMAL CONTRACT SIZE?

Today, a minimal contract size of $100,000 is common for most dealer companies offering their services to individual traders. This contract size is quite affordable from all points of view. It allows traders to conduct reasonably effective money management with limited capital. It also makes it possible for small individual investors to participate in money speculation. Finally, it is a reasonable compromise between the required minimal deposit amount and potential profit level in absolute money nomination.

WHAT ARE THE REQUIREMENTS FOR THE OPERATION ACCOUNT SIZE (MINIMUM DEPOSIT)?

Evidently, the more the investment capital, the easier, safer, more flexible and more effective should be its management. The investment and financial means of traders differ. It is a common situation when somebody willing to participate in speculative trading in a currency market simply does not have enough funds to open an account corresponding to the required safety rules. Each trader has his or her own security level, but I think (although it is a debatable issue) that the operable account size for the individual speculative trader begins with a minimal amount of $30,000, assuming that the initial margin is 2 percent and the minimal contract size is $100,000. I think $30,000 is the required minimum amount correspond­ing to FOREX market conditions, considering the following:

•  If trading a single minimal contract of $100,000, a trader loses a pip
amount equal to an average daily swing corresponding to $600 to
$1,000 (depending on the selected currency pair), then the loss of 2 to
3 percent of the account per single transaction is rather painless. This
loss cannot ruin the account, even in the case of a few consecutive
losses.

•  Traders must consider that the market "noise" amplitude approxi
mates the amplitude of the average daily exchange rate fluctuation.
Therefore, setting shorter stops while trading on a medium or longer term is unreasonable, because these stops can be offset by incidental oscillation ticks.

•  Some trading strategies recommended in this course suggest position
reversal and doubling the contract size at the same time, which de
mands some additional margin for the safety of the corresponding
working capital.

•  Traders should take into consideration that the trader's job should be
adequately reimbursed, including psychological stress, time, and ef
fort spent. There is no reason to spend up to 14 to 16 hours per day
trading if you can earn the same money in a less stressful job. Simple
calculation shows that even doubling of trading capital in one year
can provide you with a secure income, but only in the case of an ade
quate initial investment.

WHAT ARE THE TERMS OF SETTING AND EXECUTING STOP AND LIMIT ORDERS?

The ideal option is considered to be a transaction execution of stop and limit orders at a fixed price, regardless of the state of the market, its speed, and its direction at the moment. Some dealers guarantee this method of execution, whereas others reserve the right to fulfill an order with a slippage. The value of this slippage depends on the current state of the market, and can fluctuate from a few pips to tens of pips. The slippage evidently creates favorable conditions for abuse of a trader by the dealer, although it is practically impossible to arbitrate the price received from the dealer executing this transaction.

WHAT IS THE SPREAD SIZE AND ITS DEPENDENCE ON THE CONTRACT SIZE?

The spread is the difference between the "bid" and the "ask" prices given at any moment on the trading terminal. The smaller the spread is, the bet­ter it is for the trader. The dealer's spread size of five pips at the minimal contract size of $100,000 in a steady market can be regarded as adequate and acceptable, because it does not exceed the 5 percent limit of average daily deviation of currency rates. Some dealers, when trading contracts of $500,000 or more, do offer a spread of less than five pips to their clients. If you do not plan to trade contracts of $500,000 or more, you have to find a dealer who can maintain the minimum spread provided for the contract— even under active and quickly changing market conditions.

WHAT IS THE OPPORTUNITY FOR ON-LINE TRADING
USING THE INTERNET AND ADDITIONAL SERVICES:
ANALYTICAL, DATA, NEWS, OUOTES, GRAPHICS,
AND SUCH?

Many dealers now offer the opportunity for on-line trading, and more will do so in the future. Internet trading has certain advantages over the traditional telephone communication with a broker or a dealer. The main advantages of on-line trading are:

•  The opportunity to monitor market movements by following current
real-time prices, graphics, and even news on a PC monitor. Usually, it
is free and is included in the service and trading software offered by a
dealer.

•  Dealer trading software as well as other options often provide the
trader with the opportunity to manipulate, modify, and customize
graphics; conduct technical analysis using indicators; and draw trend
lines, support, and resistance lines. In addition to being convenient,
this provides substantial money savings. It eliminates the necessity of
buying an expensive market-quotes service, and analytical and chart
ing software for conducting technical analysis.

•  Internet trading is supported by safe electronic registration data,
which provides the necessary security and lowers the possibility of
conflict situations between a trader and a dealer. These conflicts are
due to probable human errors and slips of the tongue, which are com
mon during live phone communications.

IS IT NECESSARY TO PAY COMMISSIONS AND OTHER PAYMENTS AND DUES?

The most reputable dealer companies charge no commissions for trans­actions executed by their clients. Others charge some commissions, but usually not very high ones. Personally, I cannot excuse some dealers charging so-called storage fees. In the financial world, the client is usu­ally paid when he stores his money—not the dealer. Reputable dealers transferring an open position to the following day execute the rollover operation in accordance with the current LIBOR rates and reflect it in a daily statement.

Depending on the currency pair and direction in which the position was opened at the moment of its transfer to the next day, the client could actually win as a result of the transfer. A certain amount would be added to his account just for holding the position open for more than one day.

Other dealer companies do not bother themselves with such calculations but simply charge the client for the interest on the position transferred to the following day. There are numerous discussions about the possibility of holding two opposite positions open when both long and short positions exist simultaneously. At a dealer's statement in such case, both positions are shown to exist in reality. Each one generates profit and/or loss, and in such form they could be transferred to the following day. I have met a few traders whose manner of trading envisaged such a condition or who used it as an important part of their trading strategy.

I think such arguments are useless and senseless. The positions cannot voluntarily be divided into new and liquidation—depending on a trader's will. The market functions in accordance with certain rules, and it is arranged in such a manner that positions of the opposite tendencies for the same currency pair and of the same size are offset automatically. The spot part of the FOREX market provides the offset and self-liquidation of all open positions by the end of each trading day. At the beginning of the next day, only those positions are recovered that had not been offset due to the lack of opposite (with opposite sign) transactions of corresponding size. For example, if the trader during the day executed USD/CHF transac­tions for the total amount of $600,000 to buy and $400,000 to sell, then the long USD/CHF position for the remaining $200,000 would be transferred to the next day. As you can see, this is accompanied by the offset of the opposite positions, and the corresponding gain/loss was deposited into or deducted from the trader's account.

There is a simple reason that some dealers allow and even encourage their clients to keep opposite positions for longer than one day. A dealer company can charge interest for practically nonexisting positions. A dealer company can also create the illusion for the trader that the trader is present at the market and should find a way out of the situation and liqui­date both opposite positions, whereas, in reality, they are nonexistent.

Many traders consider the possibility of keeping these opposite positions an advantage. This advantage allows them to hedge (or lock) their losing trades and to limit their losses in case the market moves against their initial position. At the same time, this possibility creates the illusion that loss of money is not final and that the money could be returned if the "right" way out of the situation was found. If you cannot stand the psychological stress of trading without such useless "placebo" methods, then it is better to reconsider further participation in this business.

WHAT ARE THE RISKS OF DOING BUSINESS

WITH "BUCKET SHOPS"?

Legal issues (i.e., a set of acts governing and controlling the functions of banks, dealers, and broker companies in the FOREX market, established by government agencies) are of primary importance because traders have to entrust their money to the dealers. First, it is better for traders to make sure that their money is safe and that the breach of trust is impossible for the dealer.

I am not a lawyer, so I have no right to advise my clients on legal matters. The vast majority of dealer companies function in many countries, with various rules and regulations of which I am not aware. My recom­mendations are, therefore, based on my personal experience and preferences. In any case, you had better survey the problem yourself and preferably ask a lawyer for legal advice. The following sections outline my personal opinion concerning dealer choice, considering the security of capital invested in FOREX operations.

The Problem of Dealer and Broker Companies Abusing Client's Trust Exists on a Large Scale

Many countries lack any legislative jurisdiction governing dealer-customer relationships regarding the FOREX market, or government control over dealer and broker companies involved in speculative currency trading. That is the main cause of abuse of clients, especially when the client's money is used for market speculation and when unlawful extortion is charged.

The Majority of Broker Companies— Especially Small Ones—are Bucket Shops

Bucket shops are companies that do not have direct relations with the FOREX market, and do not execute real transactions on the real market. What they do is create an illusion of trading operations whereas, in reality, they only make mutual bets around rate changes between a client-trader and themselves. These bets are based on real current market quotas, but actually have nothing to do with the real market. If the client wins, the client gets paid from the broker company's own funds. If the client loses, the money remains in the broker's pocket.

In General, Operations of Bucket Shops Are Legal and Are Not Controlled by a Government

Many experienced traders know about practices of bucket shops but do not pay adequate attention to them. They think that the sources of gain or loss coverage are of no great importance. However, in reality, this belief leads to serious mistakes. When brokers try to maximize clients' losses, it aggravates contradictions between a client-trader and a company offering brokerage service. This can have very grave consequences for the client. Usually, such brokers do everything possible to make a client's operations on the money market difficult. They have at their disposal a wide variety of tools, ranging from various commission charges and other fees that the client is required to pay for the supposedly offered services, to quota manipulations that offer the client prices that are different from current market prices. There are some cases in which such companies have been liquidated, and their owners have disappeared with the clients' money. On the Internet, you can find numerous reports of clients deceived by such companies.

How to Determine If a Broker Company Is a Bucket Shop

You can determine with great accuracy if a broker company is a bucket shop by conducting these basic features of the company:

•  The minimum necessary trading account size is less than $10,000.

•  The initial margin is less than 2 to 4 percent or is not fixed at all.

•  Positions are transferred to the next day not in accordance with the
generally accepted rules based on the corresponding current LIBOR
rates but with some other plan, and a trader is required to pay the in
terest charge at some fixed or floating rates.

•  There are some extra charges in the form of commissions for each
transaction and/or storage fees.

•  Both opposite positions can be kept indefinitely (the so-called lock
or hedge) for the same currency rate that is reflected in the client's
statement.

•  The setting of automatic stop and limit orders is governed by certain
unreasonable restrictions, preventing order setting too close to the
current market price if the fixed existing limit is exceeded, or by some
other simulated restrictions on using automatically executed orders.

Bucket Shop Practices Are Widespread, Mainly among Dealer-Broker Companies in the United States, Eastern Europe, Southeast Asia, and Offshore Zones

Because bucket shop practices are so widespread, I would not recom­mend dealing with companies in the United States, Eastern Europe, Southeast Asia or offshore zones. It's better to be safe than sorry. I think the best area to open a trading account for FOREX operations is Western Europe , especially Great Britain . The reputable and easily checked European companies, or the European subsidiaries of reputable international banks, are the best choices to provide reliable service. Furthermore, Great Britain has a governmental agency—Securities and Futures Authority (SFA)— which overrules the dealer companies in the FOREX market as well.

Before Making a Final Decision, Remember to Check the Terms of Opening the Trading Account and Corresponding Transactions

The terms to consider, about opening a trading account and carrying out transactions, include: adding interest to the deposit, the opportunity to open a segregated account, the opportunity to trade under a bank guarantee, the time schedule for money transfers from one account to another, rules governing conflicts and settlements, and such. The right choice of a dealer greatly influences the results of your trading operations.

RECENT INDUSTRY DEVELOPMENTS

Some significant changes, both positive and negative, took place in the FOREX trading world over the past few years. First let me mention three positive changes:

•  By the year 2006 the industry of FOREX trading had become more
government regulated in the United States. Nowadays, the NFA regu­
lates most of the dealers and introducing brokers conducting busi­
ness in the United States, including foreign dealing companies
providing services to U.S. customers. So, now the probability for a
trader or an investor to become a fraud victim has greatly decreased.

•  Stronger competition among numerous dealing companies has made
them offer their customers better services that include more sophisti­
cated trading software, lower spreads, and faster and more accurate
trade execution.

•  Reputable dealers now offer their customers the opportunity to trade
contracts as small as $10,000. This is good for beginners, who today
can make real trades without risking too much money while learning
the business.

However, along with positive changes there also were two negative ones: First, the same competition among dealers that improved quality of their services overall led to the situation that now almost every dealer could be considered a bucket shop. Today the dealers routinely trade against their customers, especially those individuals with smaller trading capital. In order to increase their revenues, some of the larger dealers on a daily basis carry an uncovered exposure totaling well over $100 million of the positions taken by their customers. At first glance it seems that there shouldn't be a problem. The rule of the game is that the house must always win and there are reasons to believe that most of the clients' trading capital sooner or later ends up in the dealer's pocket anyway, pretty much like in the gambling industry. (Dealers' back office statistics show that approximately 60 percent of their clients' total trading capital is being lost in trading annually.) However, unlike in the casino business where the house is always able to control each and every aspect of the game, there could be some very dramatic and fast changes in the market that wouldn't allow the dealer to cover its exposure before it becomes too late. Unexpected, almost instantaneous, and sizeable shifts in currency exchange quotes could be damaging to the point where a dealer would not be able to fulfill its financial obligations toward its customers.

The other change that I consider to be rather negative is the trend of most dealers lowering their margin requirements. Today it is quite possible to find a dealer offering to its customers a margin as low as 0.5 percent. Dealers present low-margin trading as an opportunity for customers to achieve greater profitability with smaller investment capital. It is true, but trading on full leverage also could easily cause the loss of the entire trading capital in a single trade in a matter of minutes. It looks like trading in the financial market is turning into a casino-style business, which is not good in my view.

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